WillScot Holdings Corporation (WSC) Q3 2019 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen and welcome to the WillScot Third Quarter 2019 Conference Call. [Operator Instructions] I would now like to turn the conference over to your host Mr. Matt Jacobsen, Vice President of Finance. Please go ahead, sir.

Thank you and good morning. Before we begin I'd like to remind you we will discuss forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forward-looking statements as a result of various factors including those discussed in our press release and in the risk factors identified in our 2018 Form 10-K filed with the SEC and our Form 10-Q that will be filed today. While we may update forward-looking statements in the future we disclaim any obligation to do so. You should not place undue reliance on these forward-looking statements all of which speak only as of today. We would like to remind you that some of the statements and responses to your questions in this conference call may include forward-looking statements. As such they are subject to future events and uncertainties that could cause our actual results to differ materially from these statements. WillScot assumes no obligation and does not intend to update any such forward-looking statements. The press release we issued last night and the presentation for today's call are posted on the Investor Relations website. A copy of the release has also been included in an 8-K that we submitted to the SEC. We will make a replay of this conference call available via webcast on the company website. For financial information that has been expressed on a non-GAAP basis we have included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today's earnings release. Lastly this morning we are filing our 10-Q with the SEC for the third quarter of 2019. The 10-Q will be available through the SEC or on the Investor Relations section of our website. Now with me today I've got Brad Soultz our President and CEO; and Tim Boswell, our CFO. So, I'll kick off today's call with a brief overview of the company summarize our third quarter results and provide an update on some of our key performance indicators. Tim will then provide additional detail on the financial results for the third quarter and discuss our outlook for the rest of the year before we open up the call for questions. With that I'll turn the call over to Brad.

Thank you Matt. I'd like to welcome everyone to WillScot's third quarter 2019 conference call. Please turn to slide six of our investor presentation as I would first like to highlight 4 key aspects of our financial performance indicative of the transformation we've undertaken and the strong momentum with which we'll be entering 2020. First we generated $272 million of revenue which is up 24% over the same period in 2018. While as expected on a pro forma basis our consolidated revenue was down 9% our U.S. modular leasing revenue was up 8% versus the prior year as we continue to transition the acquired portfolios deemphasizing sales and in turn emphasizing and expanding the higher-value leasing ready-to-work aspects of the business. Importantly Q3 marked the one-year anniversary of our acquisition of ModSpace and in turn the final quarter in which we expect to see meaningful year-over-year change in mix of sale and leasing revenue. The evidence of our success in this strategic shift is apparent in the U.S. modular space average rental rates which were up 15.1% year-over-year on a pro forma basis driven 40% by increased value-added products and services or VAPS penetration and 60% by pricing on new contracts as the acquired portfolios continue to return and are redeployed. This is the eighth consecutive quarter of double-digit rate growth, and we expect this momentum to continue for years to come. Second, we generated $88 million of adjusted EBITDA, which is up 37% over the prior year. On a pro forma basis, adjusted EBITDA was up 11% on the aforementioned 9% reduction in revenue. This impressive flow through highlights the inherent leverage in our platform as well as further validates our strategic decision to focus the acquired portfolios more exclusively on the higher-quality leasing aspects of the business. The ModSpace integration is substantially complete. As such, 70% of the ModSpace-related cost synergies have been actioned and included on our results as we exited the quarter. These cost synergies, along with those of prior acquisitions, contributed $12 million of savings in the quarter on a cumulative basis. I would also note that we're making very good progress scoping and developing execution plans, targeting other potential synergies, which were not otherwise included in the initial $70 million. A few examples of the incremental potential opportunities include logistics optimization, right scale efficiencies, sourcing and procurement and further fleet optimization. Finally, in combination with the organic lease revenue growth, the revenue mix shift and cost-synergy realization resulted in 600 basis points of year-over-year adjusted EBITDA margin expansion on a pro forma basis. We've clearly established a proven track record of continued organic growth, along with swift and effective integration of acquisitions. Third, net income and free cash flow inflected and is accelerating, consistent with our planned second half 2019 transition to net profitability and cash generation. Both were positive in the quarter, with net income up $37 million and free cash flow up $43 million on a year-over-year basis. Fourth, and in summary, we're very pleased with the third quarter results and the trajectory upon which we're entering 2020. We believe accelerating growth levers driving our business are largely in our control, but our year-to-date results provide us the confidence to achieve an annualized run rate of $400 million adjusted EBITDA, $200 million of discretionary free cash flow as we exit 2019 and to deleverage the platform to 4x net debt to EBITDA by the second quarter of 2020. Now if you'll turn to Slide 7. As noted, we're realizing a greater than 100% flow through of incremental revenues on a pro forma basis. Starting at the far left, you'll note that our third quarter 2018 adjusted EBITDA was $65 million. This would have included Tyson and Acton acquisitions as well as 1.5 months of the ModSpace actuals, given that acquisition closed on August 15. Adding in the ModSpace pre-acquisition contributions brings the total pro forma adjusted EBITDA to $80 million. Next, the acquisition-related cost synergies contributed $12 million of cost savings in the quarter on a cumulative basis, $2.4 million of which were realized in our third quarter 2018 results. We then realized $9.2 million of organic growth in the quarter primarily driven by rate optimization and increased VAPS penetration, offsetting $10.4 million of associated reductions in non-recurring sales margins, the majority of which was concentrated in 1 ModSpace hurricane export project that contributed approximately $7 million of the $10.4 million. All these build for our third quarter adjusted EBITDA result of $88 million, which was, as noted, a 600 basis points improvement in EBITDA margins on a year-over-year pro forma basis. Finally, turning to Slide 8. I'll provide a snapshot of the U.S. pro forma leasing KPIs realized in the third quarter since they provide the primary foundation for the run rate in which we enter the fourth quarter. As reflected in the top left chart, Modular Space average monthly lease rate of $632 was up 15.1% year-over-year. This is the eighth consecutive quarter of double-digit rate growth, and we expect this momentum to continue as we look ahead. I'll expand upon this important point a bit further in a moment. As expected, we saw unit-owned rents stabilize in the quarter, and we were particularly pleased with the strong sequential improvements in delivery volumes in Q3, with total deliveries up 8% versus the prior quarter. Our sales rep productivity was approximately 50% over prior year as we exited the quarter, providing us confidence in the positioning of our sales force, and, again, validating our commercial strategy as we head into 2020. Given the confidence in our demand outlook and particularly the continued expansion of the ready-to-work solutions, we're selectively expanding our sales team by about 10%. The net result was a very robust 8% year-over-year growth in U.S. pro forma modular leasing revenues, which is in line with our original expectations of a run rate heading into 2020. Turning to Slide 9. As previously mentioned, VAPS growth has consistently been driving 40% of our overall rate growth based upon VAPS penetration we have achieved on new units delivered over the last 12 months, we expect another greater than $140 million of annualized revenue growth. In the second quarter, the average rate of VAPS value per month across all of the units delivered in the 12 months increased to $284. This rate is up 20% over LTM levels achieved the prior year. This continued outperformance is particularly pleasing given the last 12 months incorporated integration of the 3 acquired portfolios. We have been very successful in combining the sales teams who themselves have been successful introducing this unique value prop to many new customers. This performance is a key driver behind the aforementioned 50% increase in sales rep productivity and is certainly above our original expectations. The associated growth in revenue will occur, as previously mentioned, over the next 3 years as units on rent are returned once their current projects end and are redeployed at our current level of VAPS penetration. As we continue to increase VAPS penetration towards our long-term stated goal, the associated revenue growth expands and extends in duration. I would note that approximately third of our on-rent portfolio was deployed by and prior to our acquisition of Tyson, Acton and ModSpace. These respective acquired portfolios were deployed without the benefit of WillScot's comprehensive VAPS offering as well as our sophisticated rate and yield management tools. And while VAPS drove 40% of the overall 15.1% rate increase, the other 60% was driven primarily by modular office pricing on new rental contracts. Although we are not disclosing the specific rates achieved on new deliveries of offices, they're obviously much higher than the average across the on-rent portfolio. One could visualize charts very similar to those on this page, depicting the convergence between modular office delivered rates we've achieved over the last 12 months and the on-rent average as the acquired portfolios continue to return and be redeployed. Stated simply, if the VAPS-related convergence is driving 40% of our rate growth and is expected to yield greater than $140 million of revenue growth over the next three years the potential benefit associated with rate optimization which is driving the other 60% is at least that amount again. Combined these 2 idiosyncratic and foundational growth drivers provide confidence to demonstrate the double-digit rate growth achieved over the last two years can extend for years to come. Before turning it over to Tim I'd ask you to turn your attention to slide 10 in order to expand on our demand outlook across our diverse end markets. First I'd like to direct you to the pie chart at the bottom left of the slide which breaks down our end markets. In addition to the very diverse group of end markets customer base is highly fragmented with no individual customer representing more than 3% of our revenue and the top 50 customers representing less than 15%. At an aggregate level we've not seen any material shift in the end market activity. Our best indicator for demand is quote activity generated by the field which has remained at or above targets and drives our order book for deliveries to new projects. So while there's clearly been some disruption both internally and externally in the first half of the year our volumes have stabilized in the third quarter and our overall demand outlook remains positive. As well our capex outlook reflects an expectation of continued reinvestment in the business going forward. We continue to monitor demand across various geographies and end markets and have a disciplined process through which we control and allocate our capital. One key strengths of our business model is the discretion and flexibility that we have over capital spending in the short term coupled with our long-term average lease terms and long-lived assets. This together allows us to reallocate reduce capital spending and drive free cash flow to the extent markets do not support growth. I'm particularly pleased with the idiosyncratic top and bottom line growth drivers already inherent on our business. Our unparalleled scale embedded M&A-related synergies and our commercial strategy to drive lease revenue growth organically through rate optimization and penetration of our ready-to-work solutions will provide continued growth largely independent of market cycles and will unfold predictably over the next several years as the acquired portfolios return and are redeployed. With that I'll hand it over to Tim who will provide additional context.

Thank you Brad and good morning. Please turn to slide 12. Q3 saw another good quarter of execution in line with our expectations for the year. The continuation of strong pricing and value-added products trends as well as cost synergy execution are all similar to prior quarters with nearly an 8% sequential increase in quarterly delivery activity being the only notable operational change impacting our Q3 results. Let's drop straight to the bottom charts which show revenue and adjusted EBITDA year-over-year on a pro forma basis. As we've highlighted previously, ModSpace executed a very large export sale related to hurricane relief and generated $26 million of revenue and $7 million of adjusted EBITDA in Q3 last year. On the left-hand side of each chart we've isolated the impact of nonrecurring sales in the quarter to show the performance of our leasing operations which is the best indicator of how the current portfolio is performing organically. This is the last quarter where we expect this year-over-year revenue mix shift to have a meaningful impact and I'll elaborate on that in a minute. Similar to prior quarters modular leasing revenue was up 7.9% year-over-year on a pro forma basis driven by pricing and value-added products in the U.S. segment. Adjusting for the approximately $41 million of revenue and $10 million of EBITDA contribution last year derived from noncore sales activity, we generated approximately $19 million of EBITDA growth from the $14 million increase in modular leasing revenue. This implies over 130% flow through in our leasing operations. This organic growth and cost synergy realization drove 600 basis points of margin expansion year-over-year on a pro forma basis. Sequentially from Q2, EBITDA margins contracted 80 basis points, which was driven by a $4 million sequential increase in variable leasing costs as well as the contraction of delivery and installation margins that we had expected. As we talked about last quarter, the later seasonal ramp-up of delivery activity effectively pushed the variable leasing costs from the first half of the year into Q3, and the higher mix of deliveries relative to returns tends to result in a lower margin in the period. Sequentially, heading into Q4, we expect the top line to continue to build modestly. Variable costs and delivery margins should revert to Q2 levels. And with continued synergy execution, margins should push back towards the 35% area. Stepping back, this is essentially the same plan in Q4 run rate expectation that we laid out in January, and we're excited about the path that puts us on for 2020. Slide 13 is new, and we added it to illustrate the long-term shift our revenue mix favoring our leasing operations given the year-over-year impact the noncore sales had in Q3 of 2018. The bottom dark green portion of the chart is our modular leasing revenue and accounts for 70% of total revenue year-to-date. There is essentially no variability here due to our 32-month average lease duration. And this gives us very good forward visibility into our results, particularly given the multiyear opportunity to improve pricing and value-added products penetration in our acquired portfolios. Next, the dark gray section is our delivery and installation, representing 21% of our revenue year-to-date. This revenue is driven by the movement of leased equipment to and from customer sites. This revenue clearly has consistent seasonality and margin movement based on customer activity levels, but it is linked to our modular leasing revenue and, thus, quite predictable over longer periods. Lastly, at the top of the chart, you see our sale revenue, which historically has been harder to predict and carries different execution risks. ModSpace had more than double the mix of sale revenue relative to WillScot at the time of acquisition and maintains 3 in-housemanufacturing facilities, which we have closed. Strategically, we've repositioned the portfolio to focus on the long-duration, low-volatility lease revenue, which has increased at over a 10% compound annual growth rate since 2017 and sits at record levels as of Q3. This obviously supports our view of the run rate heading into 2020 and, we believe, makes this a truly unique rental platform. I'm going to skip ahead to Slide 17, please. At the outset of the year, we indicated that we would transition to consistent net profits and cash generation as we head into the second half of the year. We saw that transition beginning in Q3 with a modest profit from continuing operations. Overall, net income of $800,000 was up $37.5 million from prior year as integration, restructuring and transaction costs have moderated. In total, we incurred $8.4 million of these acquisition-related items in Q3. I'll also note that interest expense declined 5% sequentially from Q2 as a result of our refinancing and the floating portion of our ABL balance. With the top line and acquisition synergies building and restructuring and interest costs coming down, we expect net income and cash generation to ramp substantially heading into Q4 and 2020. Slide 18 shows where we stand overall on synergy realization, integration and restructuring costs and real estate actions. On the left, our Q3 results now include 70% of the $71 million of total annual cost synergies that we originally identified. We remain on track to deliver 80% of the total synergy value in Q4 of this year, which has been our target since announcing the acquisition in June of 2018. In the middle chart, integration costs are winding down, although higher than our original estimate, as we shared in May. And in the right-hand chart, we generated an additional $4 million of net proceeds from real estate sales in Q3, bringing the year-to-date total to $13 million of the total $40 million that we intend to monetize. We expect to generate approximately $4 million of additional net proceeds in Q4 and expect to monetize the majority of the remainder in 2020. As I indicated last quarter, we've been pleased with the real estate valuations that we're seeing. In Q3, we finalized a third-party review of all the real estate that we acquired in the ModSpace transaction, and we've increased the value of ModSpace real estate by $28 million to reflect the fair market value at the time of acquisition. That brings the total market value of real estate acquired from ModSpace to $96 million, which will, over time, benefit WillScot shareholders as we optimize the balance sheet. Moving to Slide 19. As we have explained previously, WillScot's cash flow profile is inflecting significantly as we've executed our operating plan in 2019. We are pleased to be free cash flow positive in both Q2 and Q3 and see this ramping significantly into Q4 and 2020, consistent with our prior expectations. In the top chart, year-to-date cash flow from operations is up $83.5 million versus prior year. You can see the burden of transaction and integration costs was most significant in Q3 and Q4 of last year as well as Q1 of 2019. As we head into Q4 and 2020, we expect five fundamental levers to drive sequential and year-over-year improvement in operating cash flows, which include: our continued top line lease revenue growth; cost synergies executed on schedule and growing into 2020; integration costs winding down; interest costs have come down and have room to come down further; and working capital is stabilizing heading into Q4. In the bottom chart, you can see that net cash used in investing activities has averaged $40 million per quarter, which aligns to the high end of our CapEx guidance range for the year. We've seen net CapEx moderating as we head into Q4 and Q1, both due to normal seasonal factors as well as some of the integration-related CapEx that we've incurred and spoke about in Q2. Together, these trends point towards significant and sustained free cash generation heading into 2020. Moving to Slide 20. Our debt structure is unchanged relative to June 30, and interest costs declined 5% sequentially from Q2 due to the refinancing. We have approximately $490 million of availability in our ABL revolver. Leverage has reduced sequentially every quarter since closing the ModSpace acquisition, and we expect this pace of deleveraging to accelerate toward our 4x target by Q2 2020 as free cash flow inflects positively. And lastly we'll continue to be opportunistic in looking for ways to improve our financing costs and maturity profile as we head into 2020. On slide 21 we're maintaining the annual guidance that we had updated in August. At the midpoint of the ranges we see $1.075 billion of revenue $360 million of adjusted EBITDA and $155 million of net CapEx. Based on our expectations for Q4 we expect to carry roughly a $400 million adjusted EBITDA run rate and 35% adjusted EBITDA margin into 2020 which is consistent with what we communicated in January. Lastly I'd encourage you to take a look at slide 22 to understand some compliance and reporting changes coming up in Q4. As we've mentioned WillScot will become a large accelerated filer for purposes of our 10-K due to our growth. The practical implications of this are we'll pull up our 10-K filing date earlier than prior years with a deadline of March 2. Thurston youngest performing our first controls audit precise purposes, and will be adopting several accounting standards, the most notable of which is the asca 42 weeks accounting standard. The standard was effective January one this year for existing large accelerated filers so we will adopt it retroactively in Q4 and you'll notice a couple of changes. First of all the real estate that WillScot has on operating leases will be added as assets and lease liabilities to our balance sheet. This will be roughly a $140 million increase to both our assets and liabilities including the roughly $38 million of finance leases that we currently include as long-term debt. And then second year-to-date we've incurred $7 million of restructuring expense related to leased properties that we are exiting. Under the new guidance these restructuring expenses will be recast as asset impairments. And the timing of the expense recognition will change which will impact 2019 GAAP net income and EPS but not our adjusted EBITDA. None of this impacts the cash flows or economics of the business but I wanted to let you know it's coming and also thank our team. The effort that goes into these critical compliance activities is often underappreciated but it's been essential in our transformation over the past two years. So with that I'll hand it back to Brad on slide 23 for closing comments and Q&A.

Thank, Tim. First, I would like to thank our customers and our investors for the trust in us and the entire biscuit organization for their continued performance. We have certainly established a proven track record the continued organic growth along the swift and effective integration of companies of all sizes. I remain convicted in my view, we have the right strategy and the right team to continue to increase long term shareholder value. We're extremely proud of all we've accomplished in the third quarter of 2019 and the momentum in which we expect to enter 2020. We're very confident in our ability to achieve the adjusted EBITDA run rate of $400 million with discretionary free cash flow generation of $200 million as we head into 2020 and deleveraging the platform to 4x net debt to adjusted EBITDA by the second quarter of 2020. We appreciate you taking the time to join us today and for your interest in the company. We look forward to speaking with many of you very soon. That concludes our prepared remarks. Now we'd be happy to take your questions. Operator please open up the line.

[Operator Instructions] Your first question comes from the line of Kevin McVeigh from Credit Suisse. Your line is open. Excuse me, Mr. McVeigh. Your line is open.

Great. Can you hear me?

Yes. Now we can hear you.

Sorry about that. Brad, you talked about some of the incremental synergies beyond what you've framed out with ModSpace. Is there any way to think about what that could be? And would that be applied to decelerating -- accelerating the deleveraging or just any way to think about that? And just within the context of that, I think one of the really understated parts of the story is how you've been able to integrate 2 huge assets really, really seamlessly without any hiccups. So just kudos to you on that. But just as we think about kind of the potential next leg of synergies, is there any way you get a little bit further into the year we can think about a range on that?

Yes, I think as we close out the fourth quarter, we'll be talking about ranges once we have very specific and detailed execution plans. We don't expect any significant investments required to support these opportunities. So I think the impact of leverage would just be further growth in EBITDA and earnings. We did mention the last couple of calls, Kevin, that the delivery and installation cost alone is about a $200 million annual spend, and that's certainly been our primary focus. So we see opportunities, both on the cost side of that and as -- and Tim mentioned in his commentary, on the price side as well. So that's our focus. We're not ready to provide a number until we really have detailed plans to execute, and I expect we'll be doing that as we talk about fourth quarter results.

Got it. And then one more real quick and I'll get back in the queue. Operationally, you really brought the 2 organizations together in a seamless fashion. It feels like you're in a position to continue to scale. Do you have any thoughts around what the organic versus inorganic opportunities are and what the approach would be as you think about the time given kind of where we are in the evolution of the company?

Yes. While we don't comment on any specific strategy, I would make a couple of points. For one, we clearly have been an acquisitive company. And as I noted, we've certainly established a proven track record of continued organic growth, along with swiftly and effectively integrating companies of all sizes. We created tremendous shareholder value through this strategy in the past and expect to as well in the future. We have big, small, medium acquisitions we can make. We're confident each of them could be a good fit for our company and shareholders. But, I want to be clear, we will not jeopardize our plan to be below 4x levered in Q2 of next year. And anything we do will be substantially accretive, right? The beauty of our platform right now, as free cash flow really starts to accelerate next quarter, we're well positioned to use that cash flow to drive shareholder value with many options.

Awesome. Really great job. Thank you.

Your next question comes from the line of Courtney Yakavonis from Morgan Stanley. Your line is open.

Hi. Thanks for the question guys. Just wanted to talk a little bit about your units on rent trend. I think you made some comments about seeing a stabilization. I think just the numbers that I'm looking at looks like we still saw the units -- average units on rent decline quarter-over-quarter. So just when you talked about the 8% deliveries increase, was that more weighted towards the end of the quarter? Or just help us understand kind of the thoughts on units on rent and then especially given that it's down about 5.5% year-over-year how we should be thinking about kind of the year-over-year rate heading into next year.

So, I think -- but first, I'll say it's largely in line with what we've discussed on the last quarter's call. I would point out, when I note the stability of unit on rent, we were still experiencing declines in the second quarter. The third quarter on rent was pretty stable from where we entered to where we exited, and that was very pleasing. So I mean, I still expect -- we said 4% to 5% down at the end of the year, and I still think we're on range to achieve that.

Yes, Courtney. This is Tim. I'd just say what would matter from our perspective the most is what is the lease revenue run rate at any point in time. Unit on rent is a piece of that equation, right? So lease revenue was up 2% sequentially, 8% year-over-year and is on a 10% CAGR since 2017. So there will always be some puts and takes in terms of the recipe to deliver that, but we're very confident in the lease revenue run rate. And the year-over-year comparison at this point kind of is what it is. It will be down for the next quarter or two. What matters is where do we go from here sequentially with volume and pricing. And we are just happy to see the pickup in delivery volumes in Q3, which gives us more confidence now going into Q4 and the budget for 2020.

Okay. Got you. Also just on the other North America side, I think you guys have been kind of talking down rental rates. I think there was a big contract that you guys had in the second quarter. But obviously, those surprised and were roughly in line with that 5%, similar to last quarter. So just wanted to understand if there were any other onetime impacts there and just kind of how we should be thinking about rate growth on the other North America side.

Yes. This is Tim. You did see that -- you're probably referring to the $618 average monthly rental rate in Q3 did tick up a bit from Q2. I'd expect that, as we've said last quarter, to moderate a bit, back down to the levels that you would have seen towards the end of last year. There has been some kind of unique project activity in Western Canada and Alaska, and that'd be our shorter duration. So I'd still say that maybe we're off by a period there, but I would expect those rates to moderate a bit. Overall, though, the other North America segment, I mean, if you look at the volume side, since you asked about volume, you just got a couple quarters of sequential volume growth. You've got some tightening in utilization, still far below where it can go to. But I would say the leading indicators in the other North America segment are all positive, albeit on a smaller part of the business. So it's a good signs north of the border, in particular, as well as in Mexico.

Great. And then just lastly, I think you made some comments about expanding the sales team. Can you just help us understand, were there any consolidation efforts on the sales teams during the acquisitions and kind of where this increase will be dedicated towards?

So the -- we did make some reductions. And certainly what would have been the combined sales team of ModSpace and Scotsman. They were pretty modest right in that we endeavor to maintain relationships that the various sales reps brought to the team. I would think of it simply as with each engagement with the customer right you acquire the lease you price the box and then you get into the more consultatory-type sale associated with VAPS. That takes more time. We're realizing more success than we expected. So we're simply adding a bit of capacity largely to fund that continued growth in VAPS.

Okay. Great. And if I could just squeeze in one more just on the portable storage side. Just curious your thoughts on that business. Obviously it seems like it's pretty consistent utilization rates and the rental rate. So just curious what's your thoughts are there and if that's the right scale for your business right now.

Yes, I mean we have talked about this a number of times in the past but I think it's a great business great unit economics very similar to fully VAP offices. I think the majority of our customers actually are utilizing offices and storage. We've got over 90000 offices on rent less than 20000 storage containers. So obviously there's a potential to bring those scale more in balance if you will. So it's one over time we're really excited about. We have a number of options including organically to scale that up over time.

Your next question comes from the line of Scott Schneeberger from Oppenheimer. Your line is open.

Morning, This is Daniel on for Scott. Could you please discuss the swing factors in the fourth quarter to achieve the high end of the 2019 guidance potentially?

This is Tim Daniel. The 2 biggest factors from my perspective was any unforeseen sale activity. That can be the one piece of the business that I think in this case could surprise favorably. I don't have any data pointing to that but probably that is one area. And then the interesting thing as you know in this business as you saw in Q3 if we have delivery volumes in particular move either favorably or unfavorably relative to our expectation you incur that direct variable cost in the period in which the unit moves. So perversely if delivery volumes are way ahead of our expectations in Q4 that would actually put pressure on the cost side. And the reverse would be true if delivery volumes moderated more than expectations. So it's this kind of onetime in theory to us that probably have the most potential to move the EBITDA result. Obviously at this point the lease revenue result is largely baked.

Got it. How far out do you feel you have visibility into demand conditions across the core markets?

Yes. I think obviously we have orders in hand that represent a month plus and strong quotes that would take us out at least a quarter. We look at this quarter-over-quarter. The macro indicators if you will I think still would support 1%, 2% growth next year perhaps more. So from our perspective, what we see in the order book, quite strong. What we see in quote activity, quite strong. Beyond that, we just keep an eye on the macro markets and flex our capital between regions and areas if needed to. And we'll pull back in total at a consolidated level if we need to. We're just not seeing any indicators right now that we need to do that.

Daniel, I'd say that commentary applies to new product deliveries in terms of the overall leasing portfolio. As you know, we're looking out several years in terms of the installed base. The contractual revenue stream that's in place as well as the expected duration, which obviously extends typically well beyond the contracted duration.

Got it. Thank you. Final one for me. I mean the VAPS rate is growing at a 20% clip here. How would you categorize the potential for sustaining that type of growth? And what would that mean for the long-term VAPS opportunity in terms of incremental revenue?

Well, it was in the slide deck, right? We've articulated that if we just hold the delivered rates we've demonstrated over the last 12 months, over the next 3 years, we'll realize $140 million -- over $140 million of revenue growth. About 80% of that falls through the EBITDA. So that's clearly, let's say, in our line of sights. And it simply assumes we perform at the current level of VAPS delivery. Our long-term goal is to achieve $400 per month, the value of VAPS per delivery. That compares to the $284 million we're at now. So you can kind of do the same math between $284 million and $400 million, you get well over another $100 million of potential revenue. Again, that will be paced by how quickly we can get to $400 million. And then to harvest that, it's 3 years thereafter as the portfolio churns, as Tim mentioned before. So that's one of those idiosyncratic levers that is quite exciting about this platform.

I would just highlight, Daniel, on that Slide 9, we provided some new information, in which you see for 5 years, prior to any of our acquisitions, value-added products revenue per unit is growing at 20% CAGR. After the acquisitions, it's now accelerated to 25%, and that's driven by continued penetration across the legacy WillScot platform as well as the acquired portfolios, which are largely underpenetrated. So we're quite excited about that acceleration of the revenue growth on a larger base.

Got it, thank you. Good work, guys.

Your next question comes from the line of Manav Patnaik from Barclays. Your line is open.

This is actually Greg calling in. Just want to ask about that CapEx. I think you typically talk about $100 million of maintenance CapEx. But obviously, with the growth, you're investing more this year. I guess without looking too far ahead in a status quo backdrop, is there expectation that you'd continue to spend there? And is that $160 million type number kind of the high end of what you could possibly do just given the timing on the leases coming back in?

Hi, Greg, this is Tim. So our original guidance for the year was $100 million of net maintenance CapEx. We define maintenance CapEx at the investment level required to maintain constant units on rent, so volume neutral. We are investing round numbers, another $30 million of value-added products CapEx given the growth that I just talked about. And there has been some additional fleet refurbishment in 2019, along with about $15 million of acquisition-related CapEx that includes some VAPS inventory, rent expansions and some new fleets that ModSpace had committed to at the outset of the year. So those factors together take us to the high end of the $160 million. Looking into next year, I think it'd be very much -- very similar formula. Our views of maintenance CapEx have not changed. We will absolutely continue to invest in the value-added products program. And then incremental fleet investments will be market dependent. I'll remind you that there are no long-term purchasing commitments in this business. The -- we're on basically a 90-day capital planning cycle. And every quarter, we're looking at a forward demand outlook from our branch network and doing a zero-based capital budget and redoing it every quarter. So we will be nimble as market conditions change favorably or unfavorably. But sitting here right now, I'd budget a very similar capital outlook to what we had guided towards at the beginning of 2019.

Yes. That makes sense. And then maybe quickly, I know it's a smaller part of the business, but wondering what you're seeing from your upstream oil and gas part of your business given some of the volatility that market has shown.

We have virtually no exposure to upstream. Upstream would be less than 4% of our total revenues. We haven't really seen any significant shift in that. And the majority of that would be related to Alaska, a little bit in Southern Mexico and Western Canada, all of which have been at least stable. So it's a little piece, yes.

Your next question comes from the line of Philip Ng from Jefferies.

AMR was up nicely again in the quarter. How much of the unit rate growth is driven by acquired leases rolling into the price optimization platform versus price increases on lease revenues? And do you expect this lift to moderate in 2020 after a very strong year?

Phil, it's Tim. We haven't disaggregated the pricing growth in that way. It is a good question. What Brad said in his remarks was about 60% of the year-over-year growth was driven by core rental rates with the remainder coming from value-added products. If you disaggregated the core rental rate movements, there are three different levers within that. There is the year-over-year change in delivered spot rates on new contracts. There is the dynamic you mentioned with acquired units now being repriced under our segmentation model. And then there is the ability to manage rental rates on the installed base when units go beyond their minimum contractual term. So when we talk about pricing, we're actually managing multiple levers to drive that result, which is one of the nice attributes of the business. As we go into 2020, look, you're moving off of a larger base. So yes, I would expect the percentage year-over-year growth to moderate, but we've been positively surprised through the course of this year in terms of the magnitude of the growth.

We were running 10% organic growth double-digit organically right? We certainly have seen some acceleration as we absorb these acquired portfolios. So as I mentioned before double digits for multiple years to come. I feel very comfortable with, I'm not saying that it'll continue at 15%.

That's great. And then can you provide a little more color on how quoting and deliveries tracked intra-quarter? And how that's progressing in October and early November? And when you think about 2020 how do you think about unit on rent growth appreciating WillScot has a clear preference for price mix over volume?

Yes. So this is Tim. In terms of what to expect this is similar to Courtney's question which is where do we go from here sequentially in a normal year you would typically expect some seasonal tapering of unit on rent in Q4 into the first part of Q1 with the kind of normal busier delivery season picking up into March April May time frame. So sitting here today I think a realistic expectation is let's talk about meaningful sequential unit on rent growth in kind of March second quarter time frame. And that's just a function of the natural seasonality in the business. And that really in no way it changes our view of the run rate going into next year or the range of potential outcomes for 2020 which we will talk about in Q4.

Okay. But would you expect a better growth here in 2020 just because this year has been obviously noisy with the integration of ModSpace? I just want to understand that because you did provide some color in terms of how you think about the market. But as it relates to WillScot it would be helpful.

Yes. Stable. I mean as we've said before I mean certainly stable and up 1% or 2%. And that's again our kind of track record organically. Clearly we had some disruption in the first part of the year. We've seen things stabilize. So I feel quite good about that.

Got you. And just one last one for me. Now that ModSpace is fully integrated curious what your appetite and bandwidth to engage in any larger deal. And any color on your M&A pipeline and nuances between how you're thinking about module leasing versus portable storage in terms of opportunity set?

No. As I mentioned before I think both modular office and portable storage are interesting to us as I mentioned in my comments before. We've demonstrated a very solid track record of both continued organic growth and acquiring and integrating companies of all size. ModSpace is in large behind us. We have the capability and capacity to do another. There are many opportunities out there. Pipeline is quite robust. I would just reinforce again we will not do anything that would inhibit our ability to get to the 4x net debt to EBITDA leverage by the second quarter of 2020 which is frankly right around the corner.

Thanks for calling really appreciate.

Your next question comes from the line of Ross Gilardi from Bank of America. Your lines open.

Yeah, thanks, guys. I'm Just on that note I mean I was just curious about once you get to the 4x in the second quarter what's your willingness to re-lever the balance sheet and above that for a temporary period of time if you thought you could get back to that level in a year or two and your overall willingness to use equity to fund a larger transaction?

Ross this is Tim. That question is situation-specific right? I'll use the ModSpace acquisition as an example but any of this financing decision would be in the context of the market at that point in time, whatever it may be. But for ModSpace, it was a unique asset. We knew it really well. We understood the lease revenue dynamics in the business and what we could add to that in terms of value-added products and pricing. We have thoroughly diligenced the cost synergies, so we had a very high degree of confidence in that execution, which I think you've seen. And all of those factors played into our willingness to take leverage above our stated target of 3 to 4 times. So it's hard to give you a specific answer. We have done it before in a unique circumstances where we were highly confident in the expected future cash flows of the business.

Got it. Thanks. And just on a separate question, I apologize if you've already covered this. But clearly, you guys got to your target of getting to GAAP EPS getting to a positive number in the third quarter. And you suggested that, that would continue to improve. There's been a lot of noise below the operating profit line side to ModSpace and other one-off costs. Can you help us at all in understanding the puts and takes into 2020 on the stuff below the line in terms of restructuring costs and integration costs and some of the other lines that probably you already covered that?

Not in detail, Ross. So happy to give it a shot. First, let's start with interest expense. You saw that come down 5% sequentially in the quarter. I think there's some room to improve there over time with various refinancing alternatives. So we'll see what we can accomplish there in 2020. In terms of the integration and restructuring costs, you've seen that taper down to an $8 million quarterly level, and that will taper further to zero as we get into kind of Q2 of next year is our expectation. We're very close to it. So that noise absolutely should moderate significantly, which has been our goal and expectation all along here. Taxes have been a bit quirky. But as we go into next year with consistent net income or pretax income, I'd guide you toward a mid-20s effective tax rate, which would be typical. Obviously, our cash tax profile is very attractive with a 5- to 7-year U.S. federal income tax shield, thanks to our NOLs. So I'll pause there. And if you have a follow-up question, feel free.

That's okay. So the $8 million a quarter, was that -- sorry, was that integration and restructuring? Or was that one versus the other?

That includes both.

Okay. Okay, great. Thank you.

Your next question comes from the line of Brent Thielman from D.A. Davidson. Your line is open.

Great. Tim, maybe one more line item for you. You've done a great job driving down the SG&A. Any guideposts you could give us on where you think that could land in 4Q?

In Q4, so let's see, when we adjust out the nonrecurring items that Ross was just asking about, we'd expect kind of modest reduction into Q4 from here. So a couple of million dollars.

Okay. Great. And then I guess my follow-up question. It's a little hard to tell because I know you're transitioning these older units out from the transactions. But with the hard push on rate, have you seen any fluctuations in market share to local or regional level? And I guess I'm curious, have they even improved a little because you're actually offering this sort of broader portfolio to the customers that you didn't years ago?

Yes. It's just a couple of points. I mean we are always testing the price/volume elasticity. It's not been our strategy to trade one for the other, nor do I believe we have. I certainly believe this VAPS offering has changed the game. We're delivering a critical service to get the project started, and we're there until the end. So the easier we make that for our customers, the more value they realize and the more we can extract in rate. So I think if I look back a year ago and looked across our geographies, I would have said a year ago the last in the Central Plains. The other segment, as Tim mentioned, is really in line with our expectation. The Gulf Coast states are ahead of where I would have expected one year ago. And the Mid-Atlantic and Northeast is a little bit lighter right now. But overall, portfolio looks great. I'm just sharing that color as, I mean, that's what we're looking at every quarter, as Tim mentioned, and adjusting accordingly.

Okay. A quick follow-up. I think, in the past, and I know it's relatively incremental, but sometimes, these sort of disastrous areas presented a pickup in units out. I'm just curious if the wildfires had -- out in the West Coast had an impact on your business?

I mean those all do locally. I mean we typically benefit. It's just -- it's such a large portfolio now. Each one of those individually is a very small percentage. Hurricane Harvey was one we've talked about in the past. That would have been, like, 1.5% to 3% of our total unit on rent portfolio, larger now less than -- or a smaller amount now given the scale of the company. So the other meaningful at the local level, they're usually supportive of rate for a period in that local market. And it is one that we -- given our unparalleled scale, we were uniquely positioned to respond and react, right? When we suffer and our communities suffer a shock like that, we can bring fleet from effectively all over the country, all over North America if we need to provide immediate relief.

Your next question comes from the line of Ashish Sabadra from Deutsche Bank.

So just a couple of quick clarifying follow-up questions. Just on the delivery, the 8% sequential improvement that was pretty strong, how does it compare to historic seasonality? And also the rate at which the -- some of the units are coming back, how has that compared to your expectations or compared to normal seasonality?

Yes. The delivery side of the equation, the only significant difference this year is we would have expected that pickup earlier in the year, more so like Q2, in terms of the sequential pickup. So when I say the delivery volumes materialized later in the year, it's that dynamic where you're getting that sequential quarter-to-quarter increase in Q3 rather than in Q2, and that then has implications for the variable cost timing, which I've tried to highlight. On the return side of the equation, frankly, we haven't seen any surprises there. That's something that we model at the portfolio level based on the contracted duration we see in the portfolio as well as our historical experience with how long units typically stay out.

Okay. And then on the month-to-month price optimization you are planning to roll out more sophisticated price optimization on that front I was wondering if you've been able like any update on that front?

Not yet is the answer. We have recently completed what I'd call an annual refinement of our pricing model as it relates to upfront rental rate prices. And I would think of that as just a recalibration now that we've got nine months of data from the combined delivery activity across the portfolio. But to your point there is a pricing road map that we have in the business. Applying the segmentation tool to out-of-term rental rates is an opportunity. Being more sophisticated on delivering installation pricing is an opportunity. Brad mentioned that as one lever that should support D&I margins over time. So pricing continues to be a very interesting lever in the business.

That's good. That's great. And then maybe one last one on the logistic optimization. I know there were things that you're planning to do in terms of maybe in-sourcing some of it and plus some of the technology that you've implemented around that. I was just wondering has there been any update on that trend not so much on quantifying it but more importantly the progress that you've made on optimizing the whole logistics piece?

The logistics piece so Brad spoke about this a bit earlier. We've got a team of internal and external resources actively working on it. We've got a $200 million annual cost base that we will be tackling. Think of this as largely in-sourcing versus outsourcing question and what is the right mix of that for our business now that it's roughly double the size it once was. We don't see any significant upfront capital cost to tackle this problem rather a substitution of resources over time that should support our D&I cost structure. And we'll talk more about that specifically I expect in Q4.

Thanks again.

Your next question comes from the line of Sean Wondrack from Deutsche Bank. Your lines open.

Hey, guys.So just as made some comments about SG&A earlier and you also kind of noted that you've made some hires there. Should we expect to continue to see improvement on the SG&A line? I think you did around 25% of sales this quarter which is pretty good. It was also your higher-volume quarter. How should we expect that to sort of trend over the next couple of years?

Well certainly going into Q4 we expect it to reduce further by a couple of million dollars. And as a result it will continue to reduce as a percentage of sales. I'd say the SG&A-related cost synergies are largely executed at this point. There will be some occupancy costs in 2020 that continue to taper off but you would also have some normal inflationary things at leased properties merit increases across the head count so I think we're getting to a pretty reasonable foundation in Q4.

And I certainly wouldn't be worried about it on a percentage basis. We're adding salespeople to drive incremental revenue right? So these are kind of no-brainer investments. And they're kind of de minimis when you look at the grand scheme of things.

And some of that's already into Q3 it sounds like it. So I don't view the sales head count commentary as a meaningful SG&A move one way or the other.

Okay. And typically, when you add head count like this, is there a little bit of a lag before you're able to realize the revenue from training the employees, et cetera?

I mean we have a pretty large sales team, right, so this is a very modest add that actually began in July this year. So there is certainly a small lag from when you bring someone in the door to when they're producing, but that's a primary focus of our commercial excellence team, to bring those folks up to speed as quickly as possible. We've got great tools at their disposal to be productive quickly. So it is a smart add.

That's helpful. And then you've obviously been pretty disciplined about M&A, as you could see in the numbers and your ability to gain operating leverage here. You've sort of stated that for the right opportunity, you'd consider going over the 4 turns threshold at a certain point. For the right opportunity, would you be willing to use equity as currency? Or how do you think about sort of a ceiling on where you allow things to go for a short period of time?

What we said is we did go above once with clear line of sight visibility. We've looked at that deal in 2016 in detail. We knew exactly what to expect. And I think our results have proven that out. I've also said we're not going to go into anything that would jeopardize us getting into the high side of our 3 to 4 leverage range by second quarter of next year. And as Tim said, every deal is a bit situational. We'll look at it. And certainly, equity is something we could use to finance the right transaction. It's just situational.

Right. That makes a lot of sense. And then just lastly, as you look at your capital structure now, obviously, you have some callable debt coming through. You also have a decent bit drawn on your revolver. Would you consider terming out some of that revolver debt over time as you get into more of a permanent capital structure there?

Well, again, this is another opportunistic and market dependent decision. Sitting here today and you got $490 million of availability on our revolver and a business that is inflecting significantly cash flow positive, so there's no immediate liquidity need in the business that would require you to term that out. And the cost of financing on the revolvers are actually quite attractive in the kind of the mid-4% range at the moment. I think we've got opportunities to improve on that. So what I can say is we're still a relatively new public company. I think every quarter that goes by, we've established a track record of performance, both organically and with the acquisitions that we've done. I think that's reflected in the -- our bonds trading above par, for example. Every time we've been to the market, we've been able to improve on the overall cost of capital. And we expect, as we continue this track record, that will continue to be the case.

Great. Great job. And thank you for answering the question.

Thanks.

I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Brad Soultz. Please continue.

All right. Well, again, I'd just like to thank all our customers, investors and the WillScot team for continued performance, and look forward to speaking with all of you very soon, if not, when we announce our fourth quarter results. Thanks. Have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.